5 Things You Need To Know About Your LLC's Operating Agreement: Easily Set Your Business On The Right Path
The importance of operating agreements for LLCs, including the history of operating agreements, specific clauses to include, benefits and risks, and steps to take to create one.
The Importance of Operating Agreements for LLCs
You’re probably excited about launching your new business venture. You've got a great idea, a solid team, and the motivation to succeed. But before you get too far down the road, there's one thing you need to make sure you have in place: an operating agreement for your limited liability company (LLC).
An operating agreement is a legal document that outlines the ownership structure and operating procedures for an LLC. It's a critical piece of your business and one that should not be overlooked. Let’s explore the history of operating agreements for LLCs, the specific clauses in each part of the operating agreement, and the benefits and risks that can come with not having one.
Part 1: The History of Operating Agreements and LLCs
Limited liability companies (LLCs) were first introduced in the United States in the late 1970s as a hybrid between a partnership and a corporation. They were designed to provide the liability protection of a corporation with the tax benefits and flexibility of a partnership. However, at the time, there was no legal requirement for LLCs to have an operating agreement.
It wasn't until the early 1990s that operating agreements began to gain widespread acceptance. This was due in part to the growth of the internet and the rise of tech startups, which created a need for more formal business structures. As more and more entrepreneurs began to form LLCs, it became clear that having an operating agreement was a crucial step in protecting their interests and ensuring the smooth operation of their businesses.
Part 2: The Specific Clauses in Each Part of the Operating Agreement
An operating agreement typically consists of several sections, each of which serves a specific purpose. Here are some of the most important clauses to include:
Formation: This section outlines the basic details of the LLC, such as the name, address, and purpose of the business.
Members: This section identifies the members of the LLC, their ownership percentages, and their roles and responsibilities.
Management: This section outlines how the LLC will be managed, including whether it will be member-managed or manager-managed.
Capital Contributions: This section specifies the amount and type of capital contributions each member is required to make.
Distributions: This section outlines how profits and losses will be distributed among the members.
Dissolution: This section outlines the procedures for dissolving the LLC in the event that it becomes necessary.
Part 3: The Benefits of Having an Operating Agreement
There are many benefits to having an operating agreement in place for your LLC. Here are a few of the most important ones:
Clarity: An operating agreement outlines the ownership and management structure of the LLC, which can help prevent disputes and misunderstandings among the members.
Flexibility: An operating agreement allows the members of the LLC to customize the rules and procedures for their business to fit their specific needs.
Compliance: Having an operating agreement in place can help ensure that your LLC is in compliance with certain state laws and regulations.
Part 4: The Risks of Not Having an Operating Agreement
Not having an operating agreement in place can be risky for your LLC. Here are a few of the potential risks:
Disputes: When an LLC is established without an operating agreement, there is a higher likelihood of disagreements and disputes among members. Without clear guidelines outlining how decisions should be made, how profits should be distributed, and how the business should be run, it is easier for members to disagree on these issues. Disputes can quickly escalate and turn into costly legal battles, potentially damaging the business's reputation and financial stability. An operating agreement can help prevent disputes by providing a clear framework for decision-making and conflict resolution.
Certain State Laws: Every state has default laws that govern LLCs that do not have an operating agreement in place. These laws may not align with the specific needs and goals of your business, which can create difficulties for your company. For example, default state laws may not provide the protection or flexibility that your business requires, which can limit your ability to make important decisions or take advantage of opportunities. An operating agreement allows you to customize the governance structure of your LLC to best fit your specific needs and goals.
Uncertainty: Without a clear outline of the ownership and management structure, there may be confusion and uncertainty about decision-making, profits, and responsibilities. This can lead to members making assumptions about how the business should be run, which can result in conflicts and disagreements. Additionally, without an operating agreement, it may be difficult to determine what happens in the event of a member's death or withdrawal from the company. An operating agreement clarifies the roles and responsibilities of each member, outlines the decision-making process, and provides a plan for how the business will operate in different scenarios. This creates certainty and stability for the LLC and its members.
Part 5: Take Action and Create Your Operating Agreement
Now that you understand the importance of having an operating agreement for your LLC, it's time to take action and create one. Here are some steps you can take:
Consult with a lawyer: It's always a good idea to consult with a lawyer to ensure that your operating agreement is legally sound and tailored to your specific needs.
Identify the key clauses: Make sure to include the key clauses we mentioned earlier, such as formation, members, management, capital contributions, distributions, and dissolution.
Customize the agreement: Your operating agreement should reflect the unique needs and goals of your business. Customize it to fit your specific situation.
Sign and store the agreement: Once your operating agreement is complete, make sure all members sign it and store it in a safe place for future reference.
Conclusion: Protect Your Business with an Operating Agreement
In conclusion, an operating agreement is a critical document that every LLC should have in place. It provides liability protection, clarity, flexibility, and compliance, while also preventing potential disputes and uncertainty. Not having an operating agreement can be risky and costly for your business. Take action today and create your operating agreement to protect your business and ensure its success. Remember, a strong foundation is key to building a successful business.
Pablo Segarra, Esq., Founder, Segarra Consulting, a boutique firm providing legal solutions for start-ups in the film, fashion, and sports industries that want to leverage the power of digital assets.
Member of New York State Bar Association Task Force on Emerging Digital finance and currency. (Opinions are my own).
Want to book some time to talk? 👇🏽
Subscribed
© 2023 Segarra Consulting LLC. All rights reserved. Please contact Segarra Consulting at www.SCfirm.co for permission to reprint. Notice: This is provided for educational and informational purposes only and is not intended and should not be construed as legal advice. This post may be considered advertising under applicable state laws.